Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a share purchase with call option sales or the sale of covered put contracts – in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.
This past Monday, prior to the market’s opening, I posted the following for Option to Profit subscribers:
“In all likelihood, at this point there are only two things that would make the market take any news badly.
The first is if no interest rate increase is announced.
Markets seem to have finally matured enough to understand that a rate hike is only a reflection of all of the good and future good things that are developing in our economy and are ready to move on instead of being paralyzed with fear that a rate hike would choke off anemic growth.
The second thing, though, is the very unlikely event of a rate hike larger than has been widely expected. That means a 0.5% hike, or even worse, a full 1% hike.
That would likely be met with crazed selling.”
Based on the way the market was trading this week as we were awaiting the FOMC Statement which was very widely expected to announce an interest rate increase, you would have been proud.
The proudness would have arisen as it seemed that the market was finally at peace with the idea that a small interest rate increase, the first in 9 years, wouldn’t be bad news, at all.
Finally, it seemed as if the market was developing some kind of a more mature outlook on things, coming to the realization that an interest rate hike was a reflection of a growing and healthy economy and was something that should be celebrated.
It always seemed somewhat ironic to me that the investing class, perhaps those most likely to endorse the concept of teaching a man how to fish rather than simply giving a handout, would be so aghast at the possibility of a cessation of a zero interest rate policy (“ZIRP”), which may have been tantamount to a handout.
The realization that ours was likely the best and most fundamentally sound economy in the world may have also been at the root of our recent disassociation from adverse market events in China.
So while the week opened with more significant weakness in China, our own markets began to trade as if they were now ready to welcome an interest rate increase and seeing it for what it really reflected.
All was well and in celebration mode as we awaited the news on Thursday.
As the news was being awaited, I saw the following Tweet.
I don’t follow many people on Twitter, but Todd Harrison, the founder of Minyanville is one of those rare combinations of humility, great personal and professional successes, who should be followed.
I have an autographed copy of his book “The Other Side of Wall Street,” whose full title really says it all and is a very worthwhile read.
Like the beer pitchman, Todd Harrison doesn’t Tweet much, but when he does, it’s worth reading, considering and placing somewhere in your memory banks.
Many people in their Twitter profiles have a disclaimer that when they re-Tweet something it isn’t necessarily an endorsement.
When I re-Tweet something, it is always a reflection of agreement. There’s no passive – aggressiveness involved in the re-Tweet by saying “I endorse the re-Tweeting of this, but I don’t necessarily endorse its content.”
I believed, as Todd Harrison did, some 4 minutes before the FOMC statement release, that the knee jerk reaction to the FOMC decision wasn’t the one to follow.
But a funny thing happened, but not in a funny sort of way.
For a short while that knee jerk reaction would have been the right response to what should have been correctly viewed as disappointment.
What was wrong was a reversion back to a market wanting and believing that it was given another extension of the ZIRP handout. That took a market that had given up all of its substantial gains and made another reversal, this time going beyond the day’s previous gains.
With past history as a guide, going back to Janet Yellen’s predecessor, who introduced the phenomenon of the Federal Reserve Chairman’s Press Conference, the market kept going higher during the prepared statement portion of the conference and continued even higher as some clarification was sought on what was meant by “global concerns.”
Of course, everyone knew that meant China, although one has to wonder whether those global concerns also included the opinions held and expressed by Christine Legarde of the International Monetary Fund and others, who believe that it would be wrong for the FOMC to introduce an interest rate increase in 2015.
While some then began to wonder whether “global concerns” meant that the Federal Reserve was taking on a third mandate, it all turned suddenly downward.
With the exception of a very early Yellen press conference when she mischaracterized the FOMC’s time frame on rate increases and the market took a subsequent tumble, normally, Yellen’s dovish and dulcet tones are like a tonic for whatever may have been ailing the market/ This week, however, the juxtaposition of dovish and hawkish sentiments from the FOMC Statement, the subsequent press conference prepared statement and questions and answers may have been confusing enough to send traders back to their new found friend.
Perhaps it was Yellen’s response that she couldn’t give a recipe to define what would cause the FOMC to act or perhaps it was the suggestion that the FOMC needn’t wait until their next meeting to act that sent markets sharply lower as they craved some certainty.
Or maybe it was a sudden realization that if markets had gone higher on the anticipation of a rate increase, logic would dictate that it go lower if no increase was forthcoming.
And so the initial response to the FOMC decision was the right response as the market may have shown earlier in the week that it was finally beginning to act in a mature fashion and was still capable of doing so as the winds shifted.
Perhaps the best question of that afternoon was one that pointed out an apparen
t inconsistency between expectations for full employment in the coming years, yet also expectations for inflation remaining below the Federal Reserve’s 2% target.
Her answer “If our understanding of the inflation process is correct……we will see further upward pressure on inflation, may have represented a very big “if” to some and may have deflated confidence at the same time as a re-awakening was taking place that suggested that perhaps the economy wasn’t growing as strongly as had been hoped to support continued upward movement in the market.
That’s the downside to focusing on fundamentals.
As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.
As the market continues its uncertainty, even as it may be returning more to consideration of fundamentals, I continue to like the idea of going with some of the relative safety that may be found with dividends.
Last week I purchased more shares of General Electric (GE), hoping to capture both the dividend and the volatility enhanced premium. Those shares, however were assigned early, but having sold a 2 week option the ROI for the 3 days of holding reflected that additional time value and was a respectable 1.1%.
Even though I still hold some shares with an October 2, 2015 $25 expiration hanging over them, this week I find myself wanting to add shares of General Electric, once again, as was the case in each of the last two weeks.
Although there is no dividend in sight for another 3 months, the $25 neighborhood has been looking like a comfortable one in which to add shares as volatility has made the premiums more and more attractive and there may also be some short term upside to shares to help enhance the return.
A covered option strategy is at its best when the same stock can be used over and over again as a vehicle to generate premiums and dividends. For now, General Electric may be that stock.
Verizon (VZ) doesn’t have an upcoming dividend this week, but it will be offering one within the next 3 weeks. In addition to its recently increased dividend, the yield was especially enhanced by its sharp decline in share price at the end of the week as it gave some dour guidance for 2016.
There’s not too much doubt that the telecommunications landscape is changing rapidly, but if I had to put my confidence in any company within that smallest of sectors to survive the turmoil, it’s Verizon, as long as their debt load isn’t going to grow by a very unneeded and unwanted purchase of a pesky competitor that has been squeezing everyone’s margins.
I see Verizon’s pessimism as setting up an “under promise and over deliver” kind of scenario, as utilities typically find a way to thrive, but rarely want to shout up and down the streets about how great things are, lest people begin taking notice of how much they’re paying for someone else’s obscene profits.
I already own shares of Cypress Semiconductor and have a way to go to reach a breakeven on those shares which I purchased after its proposed buyout of another company fell through. I’ve held shares many times over the years and have become very accustomed to its significant and sizable moves, while somehow finding a way to return back to more normative pricing.
Following this past Friday’s decline its well below the $10 level that I’ve long liked for adding shares. With an ex-dividend date on Tuesday, if the trade is to be made, it will be likely done early in the week.
However, the other consideration is that Cypress Semiconductor is among the early earnings reporters and it will be reporting on the day before its next option contract expires. For that reason, if considering a share purchase, I would probably look at a contract expiration beyond October, in the event of further price erosion.
Like so many other stocks, they are badly beaten down and as a result are featuring an even more alluring dividend yield. However, their Monday ex-dividend date is something that can add to that allure, as any decision to exercise the option has to be made on the previous Saturday.
That presents opportunity to look at strategies that might seek to encourage early assignment through the sale of in the money call options utilizing expanded weekly options.
While Caterpillar (CAT) and others are feeling the pain of China’s economic slowdown, that’s not the case for Deere, but as is often the case, there are sympathy pains that become all too real.
Dow Chemical, on the other hand has continued to suffer from the belief that its fortunes are closely tied to oil prices. It;s CEO refuted that barely 9 months ago and subsequent earnings reports have borne out his contention, yet Dow Chemical continues to suffer as oil prices move lower.
The financial sector was hard hit the past few days and Bank of America was additionally in the spotlight regarding the issue of whether its CEO should also hold the Chairman’s title.
As with Jamie Dimon before him who successfully faced the same shareholder issue and retained both designations, no one is complaining about the performance of Brian Moynihan.
Even as I sit on some more expensive shares that have options sold on them expiring in two weeks, I have no reason to complain.
Following a second consecutive day of large declines, Bank of America is trading near its support that has seemed to hold up well under previous assault attempts. As with other stocks that have suffered large declines, there is greater ability to attempt to capitalize on price gains without giving up much in the way of option premiums.
Bed Bath and Beyond reports earnings this week and has seen its price in steady decline for the past 4 months. Unlike others that have had a more precipitous decline as they’ve approached the pleasure of a 20% decline, Bed Bath and Beyond has done it in a gradual style.
While those intermediate points along the drop down may represent some resistance on the way back up, that climb higher is made easier when the preceding decline
When considering an earnings related trade I usually look for a weekly return of 1% or greater by selling put options at a strike price that’s below the bottom range implied by the option market. The preference is that the strike price that provides that return be well below that lower boundary, The lower, the better the safety cushion.
For Bed Bath and Beyond the implied move is about 6.3%, but there is no safety cushion below a $56.50 strike level to yield that 1% return. Therefore, instead of selling puts before earnings, I would consider, as has been the predominant strategy of the past two months, of considering the sale of puts after earnings are announced, but only if there is a significant price decline.
Finally, Green Mountain Keurig is going ex-dividend this coming week, but it hardly qualifies as being among the relatively safe universe of stocks that I would prefer owning right now.
I usually like to think about opening a position in Green Mountain Keurig through the sale of puts. However, with the ex-dividend date this week that would be like subsidizing someone who was selling those puts for the dividend related price decline.
Other than the dividend, there’s is little that I could say to justify a long term position on Green Mountain and even have a hard time justifying a short term position.
However, Green Mountain’s ex-dividend day is on Friday and expanded weekly options are available.
I would consider the purchase of shares and the concomitant sale of deep in the money expanded weekly calls in an attempt to see those shares assigned early.
As an example, with Green Mountain closing at $56.74 on Friday, the October 2, 2015 $54.50 call option would have delivered a premium of $3.08.
For a rational option buyer to consider early exercise on Thursday, the price of shares would have to be above $54.79 and likely even higher than that, due to the inherent risk associated with owning shares, even if only for minutes on Friday morning after taking their possession.
However, if assigned early, there would be a 1.5% ROI for the 4 days of holding even if the shares fell somewhat less than 3.4%.
Their coffee and their prospects for continued marketplace success may both be insipid, but I do like the tortured logic and odds of the dividend related trade as we look ahead to a week where logic seeks to re-assert itself.
Traditional Stock: General Electric, Verizon
Momentum Stock: Bank of America
Double-Dip Dividend: Cypress Semiconductor (9/22), Deere (9/28), Dow Chemical (9/28), Green Mountain Keurig (9/25)
Premiums Enhanced by Earnings: Bed Bath and Beyond (9/24 PM)
Remember, these are just guidelines for the coming week. The above selections may become actionable – most often coupling a share purchase with call option sales or the sale of covered put contracts – in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.
It wasn’t too long ago that China did what it continues to believe that it does best.
It dictated and restricted behavior.
You really can’t blame them, as for the past 67 years the government has done a very good job of controlling everything within its borders and rarely had to give up much in return.
This time it believed that it could control natural market forces with edicts and with the imposition of a very market un-natural prohibition against selling shares in a large number of stocks.
In the immediate aftermath of that decision nearly 2 months ago, the Shanghai Index had actually fared quite well, especially when you consider that in the month prior that index had taken a free fall and dropped 30% over the course of 27 days.
A subsequent 21% rebound over 15 days after the introduction of new “rules” to inactivate gravitational pull, likely re-inforced the belief that the government was omnipotent and emboldened it as it went forth with a series of rapid and significant currency devaluations, even while sending confusing signals when it moved in to support its currency.
I’ve often wondered about people who engage in risky behaviors, such as free fall jumping. What goes on in their mind, besides the obvious thrill, that tells them they can battle nature and natural laws and be on the winning side?
As with lots of things in life, we have the tendency to project in a very optimistic way. A single victory against all odds suddenly becomes the expected outcome in the future, as if nature and its forces had never heard of the expression “fool me once, shame on me….”
Given China’s track record in getting what it wants they can’t be blamed for believing that they are bigger than the laws that govern markets.
When you believe that you are right or invincible, you don’t really think about such pesky matters as consistency and the likelihood that things will eventually catch up with you.
While it may not be unusual to place some restrictions on trading when things are looking dire, the breadth of the Chinese stock trading restrictions was really broad. The suggestion that those responsible for rampant speculation and “malicious” short selling might suffer anirreversible form of punishment simply sought to ensure that any remaining miscreants severed their alliance with their normal behavior.
But when you’re on a streak and no one questions you, what reason is there to not continue in the same path that got you there? It’s just like not selling your stock positions and pocketing the gains.
Since those restrictions were imposed the Shanghai Index has actually gone 1% higher, which is considerably better than our own S&P 500 which has declined 5% after today’s free fall.
So clearly erecting a dam, even if on the wrong side of the natural flow, has helped and the score is Chinese Government 1, Natural Forces 0.
Except of course if you drill down to the past few days and see a drop of about 13%, while the S&P 500 has gone down 6%.
When the dam breaks, it’s not just the baby in the bath water that’s going to get wet, but more on that, later. That downdraft that we felt on our shores blew in from China as we got sucked in by the vacuum created from their free fall.
As with other instances of trying to do battle with nature there may be the appearance of a victory if you have a very, very short timeframe, but at some point the dam is going to burst and only time can really get things back under control enough to allow an opportunity to rebuild.
This past week was the worst in over 4 years as the S&P 500 fell 5.8%. At this point people are looking at individual stocks and are no longer marveling about how many are in correction territory, but rather how many are approaching or are in bear territory.
I haven’t kept track, but 2015 has been a year in which it seems that the most uttered phrase has been “and the markets have now given up all of their gains for the year.”
While I don’t spend too much time staring at charts and thinking about technical factors, you would have had a very difficult time escaping the barrage of comments about the market having dipped below its 200 Day Moving Average.
The level that I had been keeping my eye on as support was the 2045 level on the S&P 500 and that was breached in the final hour of trading on Thursday, leaving the 2000 level the next likely stop.
That too was left behind in the dust, as is the usual case when in free fall.
As mentioned earlier in the month, those technicals were showing a series of lower highs and higher
lows, which is often interpreted as meaning that a break-out is looming, but gives no clue as to the direction.
Now we know the direction, not that it helps any after the fact.
While the DJIA ended the week down a bit more than 10% off from its all time highs, allowing this to now be called a “correction,” the broader S&p 500 is only 7.8% lower. While many elected to sell on their way out in the final hour of the week, I wasn’t, but don’t expect to be very actively buying next week, without some sign of a functioning parachute or at least some very soft land at the bottom.
Buying is something that I will probably leave to those people who are more daring than I tend to be.
However, even they seem to have been a little more careful as this most recent sell-off hasn’t shown much in the way of enticing dare devils to buy on the substantial dips.
Even people prone to enjoying the thrill of a nice free fall are exercising some abundance of caution. While I prefer not to join them on the way down, I don’t mind keeping their company for now.
As usual, the week’s potential stock selections are classified as being in the Traditional, Double Dip Dividend, Momentum or “PEE” categories.
I succumbed a little to the sell off late in the week on Thursday and purchased some shares of Bank of America (NYSE:BAC) in the final hour, right before another leg downward in a market that at that point was already down nearly 300 points.
That simply was a lesson in the issue that faces us all when prices seem to be so irrationally low. Distinguishing between a value priced stock and one that is there to simply suck money out of your pocket isn’t terribly easy to do.
As the sell off continued the following day to bring the August 2015 option cycle to its end the financial sector continued to be hit very hard as interest rates continued their decline.
It wasn’t very long ago that the 10 Year Treasury was ready to hit 2.5% and many were looking at that as being the proverbial “hand writing on the wall,” but in the past month those rates have fallen more than 40% and suddenly that wall is as clean as that baby that is continually mentioned as having been thrown out with the bath water, which coincidentally may be the second most uttered phrase of late.
After committing some money to Bank of America, I’m actually considering adding more financial sector positions in the expectation that the decline in interest rates will be coming to an end very soon as there’s some reason to believe that the FOMC’s dependence on data may be lip service.
Generally, the association between interest rates and the performance of stocks in the financial sector is reasonably straight forward. With some limitations, an increasing interest rate environment increases the margins that such companies can achieve when they put their own money to work.
MetLife (NYSE:MET) is a good example of that relationship and its share price has certainly followed interest rates lower in the past few weeks, just as it dutifully followed those rates higher.
The decline in its shares has been swift and has finally brought them back to the mid-point of the range of the past dozen purchases. While that decline has been swift, the range has been fairly consistent and as the lower end of that range is approached there’s reason to consider braving some of the prevailing winds.
With the swiftness of the decline and with the broader market exhibiting volatility, the option premiums now associated with MetLife are recapturing some of the life that they had earlier in this year and all throughout 2014.
I often like to consider adding shares of MetLife right before an ex-dividend date, but I find the current stock price level to be compelling reason enough to consider a position and perhaps consider a longer term option contract to ride out any storm that may continue to be ahead.
Blackstone (NYSE:BX) hasn’t exactly followed that general rule, but lately it has fallen back in line with that very general rule, as it has plunged in share price since its earnings report and news of some insider selling.
As an example of how easy it has been to be too early in expressing optimism, I thought that Blackstone might be ready for a purchase just 2 weeks ago, but since then it has fallen 12%, although having had nothing but positive analyst comments directed toward it during those weeks. It, too, seems to have been caught in a significant downdraft and continued uncertainty in its near term fortunes are reflected in the very rich option premiums it’s now offering.
My major concern with Blackstone at the moment is whether its dividend, now at an 8.4% yield, can be sustained.
At a time when uncertainty is the prevailing mood, there’s some comfort that could come from having dividends accrue, as long as those dividends are safe.
While it’s dividend isn’t huge, at 2.5% and very safe, Sinclair Broadcasting (NASDAQ:SBGI) again looks inviting as it followed other media companies lower this week and is now at a very appealing part of its trading range.
They have no worries about exchange rates, the Chinese economy or any of those “stories du jour” that have everyone’s attention.
Having reached an agreement with DISH Network earlier in the week to allow retransmission of its signal it saw shares plummet the following day.
Sinclair Broadcasting is ubiquitous around the nation but not exactly a household name, even in its home turf in the Mid-Atlantic. It offers only monthly options and has generally been a longer holding for me, having owned shares on six occasions in the past 15 months.
Lexmark (NYSE:LXK) was one of the early and very pronounced casualties of this most recent earnings season and it has shown no sign of recovery. The market didn’t even cheer as Lexmark announced workforce reductions.
What Lexmark has done since earnings hasn’t been encouraging as its total decline has been in excess of 30%, with a substantial portion of that coming after the initial wave of selling upon earnings being released.
Lexmark also only offers monthly options and it has a dividend yield that’s both enticing and unnerving. The good news is that expected earnings for the next quarter are sufficient to cover the dividend, but there has to be some concern going forward, as Lexmark has found itself in the same situation as its one time parent IBM (NYSE:IBM) having pivoted from its core business and perhaps needing to do so again.
With virtually no exposure to China you might have thought that Deere (NYSE:DE) would have had somewhat of an easier time of things as reporting its earnings for the past quarter.
If so, you would have been wrong, but getting it right hasn’t been the norm of late, regardless of what company is being considered.
The drop seen in Deere shares definitely came as a surprise to the options markets and to most everyone else as they became yet another to beat on earnings, but to miss on revenues.
As is the general theme, as volatility is climbing, at nearly its highest level in 3 years, the premiums are welcoming greater risk taking, even as they provide some cushion to risk.
Following its loss on Friday, even Starbucks (NASDAQ:SBUX) is now among those in correction, having sustained that decline over the past 2 weeks. With some significant exposure in China it may be understandable why Starbucks was a full participant in the market’s weakness.
Like many other stocks, the sudden decline in the context of a market decline that has led to a surge in volatility, option premiums are beginning to look better and better.
As volatility increases, which itself is a reflection of increasing risk, there is the seeming paradox of more of that risk being mollified through the sale of in the money options. The cushion provided by those in the money options increases as the volatility increases, so that the relative risk is reduced more than an upward moving market.
Starbucks, after a prolonged period of very mediocre option premiums is now beginning to show some of the reason why option sellers prefer high volatility. It’s not only for the increased premium, but also for the premium on that premium which allows greater reward even when willing to see shares assigned at a loss.
As an example, at Starbuck’s closing price of $52.84, the weekly $52 option sale would have delivered a premium of $1.64, which would net $0.80, a 1.5% yield, if shares were assigned, even if those shares fell 1.6%.
Those kind of risk and reward end points on otherwise low risk stocks haven’t been seen in a few years and is very exciting for those who do sell options on a regular basis.
Finally, not many companies have had their obituaries prepared for release as frequently as GameStop (NYSE:GME) has had to endure for many years.
Somehow, though, even as we think that the model for gaming distribution is changing there exists a strong core of those still yearning for physicality, even if in a virtual world.
GameStop reports earnings this week and it is no stranger to strong moves. The option market, however is implying only an 8.8% move, which seems substantial, but as this most recent earnings season will attest, may be under-stated.
For those bold enough to consider the sale of puts before earnings, a 1% ROI can be achieved if shares fall less than 12.1%.
As with a number of other earnings related trades over the past few months, I’m not so bold as to consider the trade in advance of earnings, but might consider selling puts after earnings in the event of a large move downward.
Lately, that has been a better formula for balancing reward and risk, although it may result in some lost opportunities in the event that shares don’t plummet beyond the strike prices implied by the option market. That, however, can be a small price to pay when the moves have so frequently been out-sized in their magnitude and offering a reward that ends up being dwarfed by the risk.
Considering that GameStop has fallen only 4.6% from its highs, it may be under additional pressure in the event of even a mild disappointment or less than optimistic guidance.
While it may be premature to begin the flow of tears and recount the good memories of GameStop and a youth wasted, I would be cautious about discounting the concerns entirely as far as the market’s reaction may be concerned.
Traditional Stock: Blackstone, Deere, General Electric, MetLife, Starbucks
Momentum Stock: none
Double-Dip Dividend: Lexmark (8/26 $0.36), Sinclair Broadcasting (8/28 $0.16)
Premiums Enhanced by Earnings: GameStop (8/27 PM)
Remember, these are just guidelines for the coming week. The above selections may become actionable, most often coupling a share purchase with call option sales or the sale of covered put contracts, in adjustment to and consideration of market movements. The overriding objective is to create a healthy income stream for the week, with reduction of trading risk.
For two consecutive summers back in 1981 and 1982 I found myself in Jackson Hole.
Although both times were in August, I don’t recall having run across any Federal Reserve types at the time. However, if they were there, they certainly weren’t staying in the same campground, but I’m guessing that their table was set much the same as mine, when big decisions in an era of 15% Fed Funds rates and the burgeoning money supply were being made.
Or maybe they were simply unwinding after a long day of exchanging white papers.
And not the type that are rolled, as good old fashioned Jackson Hole cowboys were reported to do. Too much exchanging of those rolled papers could definitely lead you into some kind of complacency. I know that I really didn’t care too much about what was going to happen next and was content to just let it all keep happening without my input.
This past week was one when neither decisions nor inputs were really required from investors as the market had its best week in about four months. With the exception of a totally inconsequential FOMC statement release, there was absolutely no economic news, or really no news of any kind at all. In fact, awaiting the scheduled remarks from Mario Draghi was elevated to the status of “breaking news” as most people were tiring of seeing celebrities getting doused with a bucket of ice, under the guise of being news.
In an environment like that how could you not exercise complacency? Going along for the ride has been a good strategy, just ask most hedge fund managers. While they, and I, were elated with the sudden spike in volatility just two weeks ago, talk of a 30% surge in volatility have been replaced by silence and sulking for them and justifiable complacency for most other investors.
Even though it was another in a series of Fridays with potentially unsettling news coming from Ukraine, this time regarding violation of their border by a Russian convoy, the market completely ignored the news, as it did the encounter of a US military jet with a Chinese fighter plane at a distance reported to be 20 feet.
That seemed odd.
Instead, all eyes were focused on the Kansas City Federal Reserve’s annual soiree in Jackson Hole, awaiting the keynote speech by Janet Yellen and then some words from her European counterpart, Mario Draghi.
For her part, Janet Yellen’s prepared remarks had no impact on markets, which were largely unchanged for the day.
The speculation that the real market propelling catalyst would come from Draghi, who was said to be ready to announce a large round of European quantitative easing turned out to be unfounded and so the week ended on a whimper, with many traders exercising their complacency by having embarked on an early start to the last of summer’s weekends.
While not going out in a blaze of glory markets again thrived on the lack of any news. In that kind of environment you can easily get used to the good times. With many believing that the Federal Reserve’s policies were responsible for those good times and having a “dove” at its helm, even with telegraphed interest rate hikes and an end to quantitative easing, auto-pilot seems so right.
Until it doesn’t.
As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum or “PEE” categories.
This week I’m drawn to summer under-performers and there appear to be quite a few among companies that can have a place even in very traditional portfolios.
In a world that increasingly seems dominated by technology and bio-technology, my initial thoughts this week are focused on heavy metal, although that may be a consequence of some neuron debilitating nights in Jackson Hole.
Deere (DE) announced further layoffs this past week and has been mired at $85 level. Despite record crop yields Deere has gone fallow of late. While I may still like to see it trading a little lower, it is definitely in the range that I like to own shares, not having done so since August 2013, despite it being a portfolio mainstay, at one point. While its premiums are somewhat depressed along with most everything else, at the moment stocks that have under-performed the S&P 500 for the summer have some enhanced appeal at the market’s current dizzying heights.
Although the question “how much further could it possibly fall?” is not one whose answer most people would want to hear, I like considering high quality companies that have under-performed, as the market adds to its own risk for reversal.
Also in the heavy metal business, General Motors (GM) has been subject to more scrutiny than most companies could ever withstand and I think its CEO, Mary Barra, has reacted and performed admirably, trying to get ahead of the news. In that process General Motors has also found itself mired, but trading in a fairly predictable range, having a nice option premium and an upcoming dividend offer reasons for consideration. However, in order to capture the dividend I may consider the use of a monthly contract, although expanded weekly options are available. With a Monday ex-dividend date, one can even consider the sale of a September 12, 2014 contract and trade off an extra week of option premium for the dividend, if assigned early.
International Paper (IP) may not be the stuff of heavy metal, but there is a chance that some of those white papers controlling our economic and banking policies were presented on their products. It’s also possible that some of those erstwhile cowboys passed an International Paper product along to their friends around the campfire, years ago.
At its current trading level, International Paper has my attention, although I do already own some more expensive and uncovered shares. Management has sequentially created value for investors through strategic spin-offs, which may continue and a healthy dividend. It, too, has under-performed the S&P 500 of late and should have limited geo-political risk, although it does have manufacturing facilities in Russia and “International” in its name.
It’s not too often that I think about adding shares of a Dow component or a really staid “blue chip.” However, despite some low option premiums that usually accompany such names, this week it just feels right, perhaps as somewhat of an antidote to geo-political risk.
Both McDonalds (MCD) and Kellogg (K) also happen to be ex-dividend this week and are generous in their distributions. Both have also taken their lumps recently, badly trailing the already mediocre S&P 500 through the first two months of summer.
While McDonalds isn’t entirely immune to geo-political risk, witness the sudden closure of its flagship Russian restaurant and others throughout the country, following the pattern initially seen in Crimea months ago, the risk seems to be limited, as the real issues are with declining American tastes for its products.
Kellogg quietly manufactures its products in 18 countries and markets them nearly everywhere in the world, yet it’s not too likely that anyone or any government will make Kellogg the scapegoat for its geo-political shenanigans. Although I’ve never purchased shares, it’s a company that I consistently look at in order to capture its dividend, but have always gone elsewhere to be requited.
This time may be different, though. The combination of under-performance, option premium and dividend, coupled with a little bit of a time buffer through the use of a monthly option contract provides some comfort at a time when the world may be a tinderbox.
Halliburton (HAL) also goes ex-dividend this week, but its puny dividend isn’t the sort of thing that beckons anyone to begin a chase. However, shares have recently been under attack. Although only mildly trailing the S&P 500 for the summer its decline in the past month has been 8%. That’s enough to get my attention in return for receiving an option premium and perhaps a dividend payment, as well.
Pfizer (PFE) is somewhat of a mystery to me. It is thought to have a relatively shallow pipeline of new drugs, has been rebuffed in its attempt to swallow up some competition and perhaps gain a tax inversion opportunity. The mystery, though, is why shares had fallen as they have done over the summer. Whatever disappointment existed due to the failed buyout was in excess of any premium that the market attached to that buyout and the favorable tax situation.
As with International Paper, I already own uncovered shares, but am willing to now add shares as it has shown the ability to bounce back from its recent lows. While its premium isn’t necessarily the most provocative, in the past it has been the ability to repeatedly rollover shares that has been the real reward.
You can add Blackstone (BX) to the list of uncovered positions that I hold, with the most recent contract expiring this past Friday. Undoubtedly, Blackstone’s prospects are tied to a healthy stock market and an overall healthy economy, as its varied business interests and investments are the real product and they live and die through the whims of both masters.
That’s the kind of risk that’s represented in its high beta and reflected in its option premiums. However, in this period of extraordinarily low volatility, even Blackstone is having a hard time generating premiums of old. Still, its recent decline, in the absence of any real news and during a market rise makes me believe that despite the warning signs, it may offer some safety, particularly if there is further strength in the financial sector, as in the past week.
I had been hoping to have my shares of Best Buy (BBY) assigned this past week, in order to have a free and clear mind when considering the upcoming earnings report this week. That wish was granted and its again time to consider a trade in shares.
Best Buy frequently offers a good earnings related trade due to its enhanced premiums, that in turn are due to its propensity for explosive earnings related moves. While the option market is currently assigning an implied move of 8% next week, an ROI of 1% can currently be achieved by selling puts at a strike level 8.7% below Friday’s closing price.
I generally like to see a larger gap between the implied volatility and the strike price returning the threshold premium before considering the sale of puts in advance of earnings. In this case, I may be more inclined to wait after earnings and willing to pile on if shares disappoint. However, with an ex-dividend date just two weeks later, rather than selling puts in the aftermath of a large share drop I might consider the purchase of shares and sale of call options.
I have no clue how suddenly its products could have become “cool” again, or why teens may now be flocking to its stores or what aggressive strategic changes CEO Jeffries may have implemented, but the sudden favor it has found among investors is undeniable, as shares have left the S&P 500 behind in the dust over the past month.
For me, that kind of share acceleration is a perfect message to consider the sale of puts as earnings are to be released.
The option market is implying a price move of 8.6%, however, a 1% ROI may be achieved at a strike level 13.8% below Friday’s close. That’s the kind of gap that I like seeing. However, as with Best Buy, there is the matter of an ex-dividend date, which happens to be on the same date as earnings are released.
If wanting to take part in this trade, that essentially leaves three different scenarios, including the commonly executed sale of puts before or after earnings. In the case of doing so before earnings the sal
e of puts in the face of an impending ex-dividend date frequently works to the disadvantage of the seller, much in the same way as selling calls into an ex-dividend date serves as a seller’s advantage.
That disadvantage is eliminated in selling puts after earnings, in the event of the share’s decline. However, another possibility, and one that would very likely include retention of the dividend, is the sale of deep in the money calls, particularly if using a monthly expiration. Additionally, if shares move higher after earnings, once the added volatility is removed the deeper in the money position may likely be closed at a small net price following concurrent share sales, allowing funds to be re-deployed.
Take that, complacency.
While I don’t necessarily believe that space aliens will descend upon us with laser rays blazing, there’s reason to increasingly believe that possibility as we learn more and more about the existence of conditions elsewhere in the universe that may be compatible with sustaining life.
Still, even with that knowledge, I don’t let it control my life and quite frankly will probably never do anything that in any way is impacted by the thought of an encounter with an alien.
The principle reason for not elevating the alarm level is that there is no point in history to serve as an example. The pattern of life on earth has been so far devoid of such occurrences, as best we know. Right now, that’s good enough for me.
However, I just don’t completely discount the possibility, because I believe that it’s of a very low probability. Besides, the vaporization process would be so swift that there would be no time for remorse or regrets. At least that’s what I expect.
By the same token I don’t expect a complete meltdown in the market, even though I know it has and can, likely occur again. Despite its probability of occurrence and my belief of that probability, I’m not really prepared for one if it were to occur, even with the extraordinarily low cost of portfolio protection. The chances of a complete meltdown, as we know, is probably more likely to occur in the near term than the prospect of laser waving aliens in our lifetimes.
For all practical purposes one is a real probability and the other isn’t, yet they aren’t necessarily placed into different risk categories at the moment.
This week’s events, however, served as a reminder that the unexpected should always be expected. With the nice rebound on Friday from Thursday’s news of the tragic downing of the civilian Malaysian airplane, the lesson may be lost, however.
One thing that we seem to have forgotten how to do in the past 5 years is to expect the unexpected. Instead our expectations have been fueled by the relentless climb higher and a feeling of invincibility. To a large degree that feeling has been justified as every attempt to fight back against the gains has been stymied in quick and due course.
I probably wasn’t alone in having that invincible feeling way back in 2007. The vaporization process was fairly swift then, as well.
Even when faced with challenges that in the past would have sent markets tumbling, such as international conflict, we haven’t seen the application of age old adages such as “do not stay long going into a weekend of uncertainty.” This Friday’s market rebound was another example in a long string of uncertainty being expected to not lead to the unexpected.
In essence with the certainty of an ever climbing market having become the new reality there’s been very little reason to exercise caution, or at least to be prepared to act in a cautious manner in the expectation that perhaps the unexpected will occur.
Our minds are wired to like and identify patterns. That’s certainly the strategic basis for stock trading for many. Predictability brings a degree of comfort, but too much comfort brings complacency. The prevailing pattern simply argues against the unexpected, so we have discounted its probability and to a large degree its possibility.
While we may be correct in discounting complete market meltdowns, as their occurrence is still relatively uncommon, that complacency has us discounting intermediate sized moves that can easily come from the unexpected. The world is an increasingly complex and inter-connected place and as seen in the past week there needn’t be advanced warning signs for any of an infinite number of unexpected events to occur.
We did get lucky this past week, but we probably expected the luck to continue if the unexpected did strike. What would really be unexpected would be to draw a lesson from our fragility standing near market highs.
As usual, the week’s potential stock selections are classified as being in Traditional, Double Dip Dividend, Momentum or “PEE” categories. With many companies reporting earnings this coming week a companion article, “Taking a Gamble with Earnings,” explores some additional potential trades.
As Thursday’s trading was coming to its close at the lows of the session more and more stocks were beginning to return to what seemed to be more reasonable trading levels.
The problem, of course, is dealing with the unexpected and trying to predict what comes next when there are really no data points to characterize what we’ve seen. Someday when we look back at these events and the market impact we may see a pattern, but at the moment the question will be “which pattern?” Is it one that’s simply a blip and short-lived as the event itself is self-limiting or is the pattern consistent with the beginning stages of what is to become an ongoing and escalating series of events that serve to erode confidence and place continuing strains on the market?
In other words, did we just witness a typical over-reaction and subsequent rebound or are we ready to witness a correction?
I think its the former, but it opens the possibility of additional incidents and escalation of hostilities in a part of the world that is far more meaningful to the world’s economies than unheralded internecine conflicts occurring in so many other places.
Interestingly, with that kind of backdrop, this week, while we begin to sort out what the short term holds, “Momentum” kind of stocks, particularly those with little to no international exposure in the hotbed areas, may be more conservative choices than the more Traditional selections.
While I like British Petroleum (BP), General Electric (GE) and Deere (DE) this week, predominantly due to their recent price drops, there is certainly reason to be wary of their exposure to parts of the world in conflict.
British Petroleum certainly has known interests in Russia and could be at unique risk, however, I believe that we will be seeing a lesser chest thumping Russia in the n
ear term as there is some reason to believe that existing sanctions and perhaps expanded ones are beginning to get attention at the highest levels. Above all, pragmatism would dictate not injuring the source of hard currency.
I’ve been waiting a while to re-purchase shares of British Petroleum and certainly welcome any opportunity, even if still at a price higher than my last entry. With earnings scheduled to be reported July 29, 2014 and a healthy dividend sometime during the August 2014 option cycle there may be opportunities over the coming weeks with these shares to generate ongoing income.
General Electric reported its earnings this past Friday and also announced the impending IPO of its consumer finance business. The market was unimpressed on both counts.
I haven’t owned shares of General Electric with the frequency that it deserved. With a generous and increasing dividend, price stability, low beta and decent option premiums, it certainly has had the appeal for ownership, perhaps even using longer term option contracts to better lock in some of those dividends. While it has significant international exposure the recent price weakness makes entry a little less risky, but even with the quality and size of General Electric unexpected bumpy rides can be possible when uncontrollable events create investor fear.
Deere is simply finally down to the price level that in the past was my upper range for purchase. With Caterpillar (CAT) reporting earnings later this week and trading near its 52 week high, there is room on the downside, as well as some trickle down to Deere shares. However, with Joy Global’s (JOY) recent performance, my anticipation is that Caterpillar’s Chinese related revenues will be enough to satisfy traders and offer some protection to Deere, as well.
On the Momentum side of the equation this week are Best Buy (BBY), Las Vegas Sands (LVS) and YUM Brands (YUM).
While Las Vegas Sands and YUM Brands certainly have international exposure, at the moment if you had to choose where to place your overseas bets, China may be relatively insulated from the unexpected elsewhere in the world.
Both companies are coming off weak earnings reports and the markets reacted accordingly. Both, however, have been very resilient to declines and finding substantive support levels in the past. With some shares of Las Vegas Sands recently assigned at current levels I would look for opportunity to re-purchase them. It’s volatility offers generous option premiums and the availability of expanded weekly options makes it easier to consider rollover opportunities in the event of unexpected price drops in order to wait out any price rebound, which has been the expected pattern.
YUM Brands is, like Deere, finally approaching the upper range of where I have purchased shares in the past. While I would like to see them even lower, I think that due to its dependence on the Chinese economy and market it may be a relative out-performer in the event of internationally induced market weakness.
Best Buy, unlike YUM Brands and Las Vegas Sands, has recently been on an upward price trajectory. I liked it much better when it was trading in the $26 range, but I believe it still has further upside potential in its slow climb back after unexpectedly bad earnings news 6 months ago. It too has an attractive option premium and a dividend and despite its recent price climb higher has come down nearly 5% in the past two weeks.
I have never purchased shares of Pandora (P) before, but love its product. At the moment I don’t particularly have any great desire to own shares, but Pandora does report earnings this week and is notable for its 10.8% implied price move. In the meantime a 1% ROI can be achieved at a strike price that is 16.4% below the current price. Those are the kind of characteristics that I like to see when considering what may otherwise be a risk laden trade.
Pandora has certainly shown itself capable of making very large earnings related moves and it is also certainly in the cross hairs of other and bigger players, such as Apple (AAPL) and Google (GOOG). However, even a scathing critic, TheStreet’s Rocco Pendola, has recently commented that its crushing defeat at the hands of those behemoths is not guaranteed.
Expected, maybe, but not guaranteed.
Facebook (FB) is also reporting earnings this coming week and in the two years that it has done so has predominantly surprised to the upside as it has quickly lived up to its vow to monetize its mobile strategy.
With an implied price move of 7.6% the strike level necessary to generate a 1% ROI through the sale of puts is 8.7% below Friday’s closing price. While shares can certainly make a move much larger than what is expected by the option market, in the event of an adverse move Facebook has some qualities that makes it an easier put option position to manage in the effort to avoid assignment.
It trades expanded weekly options and it does so with liquidity and volume, thereby having relatively narrow bid and ask spreads, even for deep in the money options.
Sooner or later, though, the expectation must be that earnings expectations won’t be met. I wouldn’t discount that possibility, although I think the options market may have done so a bit, so in this case I would be more inclined to consider the sale of puts after earnings, if share price drops on a disappointing report.
Finally, Apple reports earnings this week. It doesn’t really fulfill the criteria that I used when considering the sale of puts prior to earnings, in that it doesn’t appear that a 1% ROI can be achieved at a strike level outside of the range defined by the option market when calculating the “implied move.”
It’s probably useless trying to speculate on sales numbers or guidance. Based on its usual earnings related responses in the past, you would be justified in believing that the market had not expected the news. However, this quarter the implied move is on the small side, at only 4.5%, suggesting that not much in the way of a surprise is expected next week.
With the current option pricing, the sale of Apple puts doesn’t meet my criteria, but I would again be interested in considering either the sale of puts after earnings, if the market’s response is negative or the outright purchase of shares and sale of calls, in anticipation of an ex-dividend date coming up in early August.
Sometimes it’s just
easier dealing with the expected.